In all the fuss and bother about the coming presidential election, there has been remarkably little talk about skyrocketing US deficit and the resulting skyrocketing interest’s payments. Regardless of who is president, these are going to be the things that govern what the ruling class can do. But these concerns still don’t factor into the political discourse although they are starting to come up with increasing frequency in the financial press. So I want to take step back from all the political drama and review the essay “Why you should panic about the US Deficit” that I wrote in September of last year.
In “Why you should panic” I made two short term predictions that we can now review for accuracy. One prediction was clearly accurate. In that prediction I said….
“Soon interest payments on the federal debt will be more then all defense spending combined (probably next year or the year after that). Shortly after that it will be more then all discretionary non-defense spending combined. Then interest payments will be greater than all discretionary spending.”
As the facts stand now this is correct in regards to defense spending. From the Committee for a Responsible Federal Budget…..
In the first seven months of Fiscal Year (FY) 2024, spending on net interest has reached $514 billion, surpassing spending on both national defense ($498 billion) and Medicare ($465 billion). Overall spending has totaled $3.9 trillion thus far. Spending on interest is also more than all the money spent this year on veterans, education, and transportation combined.
As long as we don’t wander into World War III, I don’t expect the US to ever spend more on defense then interest on debt until the US government goes bankrupt. But this brings me to my second prediction that has not been as successful. And that is where I say…..
But I am figuring that the actual interest rates that the that the feds have to pay will increase over the coming year so I am assuming that federal interest costs will be in the neighborhood of 1 trillion dollars by close of fiscal year 2024.
If you want to adopt a charitable interpretation of what it means to be “in the neighborhood” this prediction still has a chance of coming true. Again from the Committee for a Responsible Federal Budget….
Interest on the debt is currently the fastest growing part of the budget, nearly doubling from $345 billion (1.6 percent of GDP) in FY 2020 to $659 billion (2.4 percent of GDP) in 2023, and net interest is on track to reach $870 billion (3.1 percent of GDP) by the end of FY 2024. Spending on interest is now the second largest line item in the budget and is expected to remain so for the rest of the fiscal year. By 2051, interest will be the largest line item in the budget.
Now since that was written the CBO has projected interest payments of $892 billion this year. If this upward trend in the numbers continues, it is reasonable to expect interest payments in the 900+ billion range. I think you can make the case that 900+ billion is “in the neighborhood” of 1 trillion. But even though you can make the case that the “in the neighborhood of 1 trillion dollars by close of fiscal year 2024” might still be a good prediction, the reasoning behind it was wrong. The problem is where I said, “I am figuring that the actual interest rates that the feds have to pay will increase over the coming year.”
What has actually happened since I wrote that is that interest rates that Federal Government pays has stalled out in the 4% range where as I thought by now it would be in the 5% to 6% range. The only reason my prediction in regards to the total interest bill may still come out good is that I was also figuring on spending as a percentage of GDP growth would stay about constant with only interest spending leading to increase spending. For the most part that is true, but non-health, non-Social Security mandatory spending increased (in GDP terms) by almost as much as interest payments have (1.1% of GDP increase in spending vs 1.4% GDP increase in interest spending). The new borrowing occasioned by this increase in spending is causing the interest bill to go up. It appears that most of this increase was a result of Biden messing around with the student loan program. So I guess if the one trillion dollars in interest payment figure is hit, we have election year politics to thank.
But to me the more interesting point is why did interest rates stabilize even in the face of this mounting growth in debt? One of the most compelling reasons to panic is the idea that interest rate bill is now so large that will create a vicious cycle of more debt creation and ever higher interest rates. We seem to have ever more debt creation part of the cycle but higher interest rate thing seems to have stalled. Why is this?
Part of the reason is that the trade deficit has been increasing since last September. What this means is that the higher interest rates have been pulling in more foreign capital and that has been helping to hold the line on the interest rate increases. If you look at a chart of the trade deficit, it has been going slowly but steadily up since I wrote “Why you should panic.” It is looking like that the trade deficit is going to be in the neighborhood of 800 to 900 billion dollars by the time the fiscal year ends.
But while that sounds like a lot of money (and it is), the federal deficit this year is projected to run about 1.9 trillion dollars. In other words, all the foreign capital rolling in will still leave a trillion dollars of borrowing that has to come out of the domestic economy. And this is why I expected borrowing cost for the US government to rise. I did not think you could pull a trillion dollars out of the US economy without interest rates rising more.
The only answer I can find that might explain this is the fact that GDP growth has been trending downwards ever since I wrote “Why you should panic.” So perhaps the extraction of capital out of the US economy to fund the deficit has been causing growth to slow down via higher interest rates for homes and higher costs for business who want to take loans. Regardless, it is now apparent that feds paying 4% is enough to drag capital out of the economy and rates don’t need to go higher for the federal government to fund this year’s deficit. As long as foreign capital inflows continue to increase it looks like that the Feds will only have to pay at the 4% to 5% rate for awhile yet.
That does not mean that we no longer need to panic. Even if the growth of Federal interest payments only continues at its current rate of increase, we are on track to go over the 10% of GDP paying out in interest payments in 7 years or so. This matters because this is level when historically speaking countries start struggling with bankruptcy. And for what it is worth, I still expect to see interest rates start rising at some point soon and the spiral to become a reality.
But one thing I have consistently underestimated is the rest of the world’s willingness to continue funding the US. And slower economic growth has historically led to low interest rates so the continued weakening of the US economy should fight against the ever increasing demands the Federal Government are placing on the capital markets. All these qualifiers aside, I would be surprised to see interest rates as low as they are now by this time next year unless the US is in a recession that is a least 6% real drop in GDP. Even in the case of recession and a resulting stalling or regression in interest rates paid, I would expect the total interest bill for the US government to keep going up. This is because a recession will result in less tax money coming in and so there will be more borrowing. All the more because regardless of who is president it seems likely that in an event of a recession more “stimulus” spending of one type or another will be spent.
I know people have been predicting a fiscal crisis for the US for a long time without anything happening but it is hard for me to understand how the US gets out of it this time. I am not expecting the US to go bankrupt next year, but I do expect there to be a steadily degrading US fiscal situation. By this time next year I would expect the federal interest rate bill to be higher in real terms and as a percentage of GDP then it is now and the federal deficit to be higher than it is now in both real terms and as a percentage of GDP as well. More importantly (because it indicates a worsening spiral), I would expect the rate of increase in both of those figures to be higher then this year. As already noted, I expect that interest rates will also be higher although I can see that if we are in a bad enough recession that might not be the case.
If I can remember, it will be interesting to look back at this next September and see how those expectations match up with reality.